How Wall Street Works - Why Companies Issue Securities
Monday, September 03, 2007PAUL KANGAS: We`re standing above the floor of the New York Stock Exchange. This is where traders buy and sell stocks and bonds every day. And whether they`re bulls, who think stock prices are going higher or bears, who think prices are going lower, they all have a single objective: to make money. Once you understand the language and concepts used in the financial markets, there`s no reason you can`t try your hand at investing in stocks and bonds yourself.
SUSIE GHARIB: Of course, the securities markets aren`t for everyone, since trading carries significant risk and offers no guarantees. But contrary to what many people think, Wall Street is not the world`s biggest casino. Unlike a casino, Wall Street serves a vital role in the American free enterprise system because it makes it possible for companies to raise large amounts of money. That`s a process known as capital formation.
KANGAS: And by providing a place where individuals and money managers can cash in their securities on a daily basis, these markets make it possible for you and me to participate in that process. To find out how capital formation works and Wall Street`s role in it, let`s begin not in Manhattan, but thousands of miles away in the tropics.
JEFF YASTINE, NIGHTLY BUSINESS REPORT CORRESPONDENT: Cruising is a pastime that`s gained huge popularity and Carnival is truly the world`s largest cruise line, carrying thousands upon thousands of passengers on its ships each week. One of the keys to its popularity is being able to offer newer, bigger ships filled with the latest amenities that people want. And that takes money -- a lot of money -- as Mickey Arison, the chairman and CEO of Carnival, told us.
MICKEY ARISON, CHAIRMAN AND CEO, CARNIVAL CORP.: It`s a capital intensive business and building new ships is not cheap. It takes hundreds of millions of dollars.
YASTINE: So where does a cruise line go for financing? In years past, Carnival went to Wall Street. In 1987, the company sold its stock to the public for the first time. It held what`s called an initial public offering or IPO, selling 27 million shares of Carnival stock for about $15.50 each. That raised nearly $400 million for Carnival. Members of the public bought these shares and became part owners. As Carnival made money over the years, these stockholders shared in the company`s profits through payments, which are called dividends and they also benefited through the appreciation in the company`s stock price.
However, the success of the company is not guaranteed. And because it`s not a sure thing, some investors prefer an investment that carries a stronger promise of payment. So, in 1990, Carnival chose a different route to raising money. It sold bonds. Much like a loan, a bond permits the company to borrow money from the buyer of the loan for a fixed period of time. In return, the bond owner is paid a fixed rate of interest until the company repays the debt. In Carnival`s case, its original bonds were 15- year, 7.5 percent, zero-coupon convertible bonds. Now here`s what all that means: 15 years is the term of the bond, the maximum length of time the company can hold that money; 7.5 percent is the yearly interest rate paid on that money; and convertible means the owner of the bond has the option of converting it into a certain amount of Carnival common stock. That could make the bond worth more if the price of Carnival shares goes higher. If you managed to hold all of Carnival`s bonds, you`d definitely be rich, but you still wouldn`t be able to control the cruise line company. In order to do that, you would have to own a majority of Carnival`s nearly 800 million shares of common stock and it would take an awfully large buy order to do that. Jeff Yastine, NIGHTLY BUSINESS REPORT, Miami.
